Portugal’s private debt mountain threatens recovery

LISBON – Portugal has won plaudits from international lenders for tackling its public debt crisis head on, but a heavy schedule of expiring private debt threatens to undermine government efforts to nurse a shrinking economy back to health.

The country’s outstanding corporate and household debt is close to three times the value of its economic output.

Some 31-billion euros of company borrowings – worth around 40% of the country’s 3-year EU/IMF bailout – falls due this year, the Bank of Portugal says. With bad loan rates soaring and credit contracting, analysts say mass corporate asset sales and a wave of insolvencies are inevitable.

Allowing firms, especially in the hard-hit construction sector, to go bust and slashing spending by heavily indebted households could send the economy into a slump that will by far surpass government estimates of 3.3% this year.

Citigroup projects a contraction of 5.7%.

That would cut state revenues and complicate the task of meeting fiscal targets under the 78-billion-euro bailout, undermining a planned return to the bond market in 2013 and increasing chances that Portugal will need more rescue funds.

“Portugal does not have to be the next Greece, but it is very much comparable if you take its overall foreign debt, including private,” Daniel Gros, director of the Centre for European Policy Studies think-tank in Brussels, said.
“Markets work on the assumption that excess private debt becomes in the end public debt.”

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Private sector debt, which EU statistics agency Eurostat says hit 249% of GDP in 2010, is the main reason why Portuguese bond yields remain unsustainable while those of other peripheral euro zone states have fallen, Gros said.

Portuguese benchmark 10-year bonds yield nearly 14%, almost 7 percentage points above those of Ireland, which was bailed out in 2010 after Greece and before Portugal.

“Plus the expected rise in credit delinquency and a massive effort on the fiscal side already being implemented — all this is weighing on growth …We think that Portugal needs to be supported for a longer period before it can safely return to bond markets.”

The government has ruled out asking for more time or bailout money, but its lenders have said they will support Lisbon until it can finance itself in the markets if the nation continues to meet its goals under the adjustment program.

SHRINKING WAGES, CONSUMPTION

While Portugal’s public debt last year was at 107% of GDP, well below Greece’s 160%, its private debt stood at 280%, comprising 178% for companies and 103% for households.

“The problem is that Portugal has every sector — public, corporate, households, banks — overindebted,” said Prof. Joao Esteves at the Lisbon Technical University. “There can be no lending (by banks) because the top priority is to deleverage.”

Gros also argues that Portugal has to be firm, allowing companies go bankrupt rather than taking over their debts or giving loans to inefficient firms to preserve output and jobs.

“The impact on GDP will be huge, but it is an unsustainable GDP … The economy has to contract until it reaches current account surplus,” he said.

He said consumption has to fall by 10-15% and wages by up to 20% for the country to get back to a surplus on its current account, which was nearly 6.5% of GDP in deficit last year.

CREDIT AT A PRICE

Loans to firms fell 3% in the fourth quarter from a year earlier to 116-billion euros, while the unpaid loan rate soared by nearly half to 6.6 percent, the Bank of Portugal says.

Its governor Carlos Costa admits banks will have to tread carefully in granting fresh credit, even after injections of ultra-cheap loans by the European Central Bank in December and February, which left lenders with a stable liquidity cushion.

“Mobilising liquidity does not necessarily mean increasing financing because the risks are still with the banks,” he said.

“…What can be done is giving them conditions to finance and expect that their own rationale makes them take advantage of all risk-justified opportunities.”

Loans to households fell 2.2% to 152-billion euros and the unpaid loan rate jumped by a tenth to 3.7%, while the consumer protection agency’s service for overindebted families hit by unemployment and pay cuts had a 60 percent increase in requests for help in 2011.

Unemployment is at a record high and the government has slashed wages in the public sector and reduced jobless benefits. It expects joblessness to peak this year at 14.5%, but analysts say it may rise above 15% this year and next.

“The danger of this all is getting into a vicious circle of recession, which would cause an increase in credit delinquency and extremely difficult conditions for banks,” said Augusto Mateus, an economic consultant and ex-economy minister.

Portuguese banks have already started deleveraging to meet tough European capital requirements, but their impairments so far have mostly been linked to government debt holdings.

Lisbon still expects a return to modest growth in 2013 but Deutsche’s Moec said he would be “very, very surprised” if that happened.

“Still, we think it can work out in an orderly fashion in Portugal. Its exports machine is working, there are no signs of dislocation of the economy and it delivers on fiscal targets.”

“I guess we would all benefit if somebody came out soon enough and said that Portugal is not default material… (and) that it will be given a couple of more years under the assistance program,” he said.

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